On Friday, Wells Fargo Advantage Funds' Institutional Cash Management released its latest monthly "Portfolio Manager Commentary: Overview, Strategy, and Outlook." In this issue, Mike Shinners and Karen Hessing discuss the "Credit Landscape," saying, "On September 19, the oversight body of the Basel Committee on Banking and Supervision (BCBS) announced and fully endorsed changes to bank capital requirements and introduced global liquidity standards. Collectively, these changes are commonly referred to as Basel III and are scheduled to be presented for approval by the G-20 at its November meeting in Seoul."
Wells explains, While much of the discussion has focused on the changes to capital requirements, the liquidity standards may have a significant impact on short term investment opportunities. The liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) are two standards broadly designed with the intention of improving the resilience of institutions during short-term liquidity disruptions (LCR) and improving asset/liability funding mismatches by incenting the use of longer-term funding (NSFR). Taken as a whole, the measures may improve the risk profile of financial institutions. However, they may also constrain investment opportunities in the short-term space as financial institutions extend funding, purchase liquid assets, and exit or reduce certain issuance programs, even as revised Rule 2a-7 reduces the limit on weighted average final maturity and enacts minimum standards for daily and liquid assets."
The piece says, "The LCR, or 'run on the bank,' ratio requires a bank to maintain a stock of unencumbered, highly liquid assets that exceed an estimate of net cash outflows over a 30-day horizon during a 'stressed' environment. While implementation is scheduled for 2015, the observation period begins January 2011, and regulators have already pushed financial institutions to increase liquid asset holdings.... The requirement to hold liquid assets against credit and/or liquidity facilities and other short-term debt may make certain types of debt issuance cost-prohibitive for both banks and borrowers to continue to issue or sponsor; such programs may include repo, commercial paper, and, in particular, asset-backed commercial paper, as well as other types of supported issuance, such as letter-of-credit-backed municipal debt.... All of this may have the effect of reducing lending by financial institutions."
It adds, "The NSFR, which is expected to be implemented in January 2018, measures the required amount of funding that is expected to be stable over a one-year time horizon, examining on- and off-balance-sheet exposures.... Stable funding includes capital, preferred stock, liabilities with effective maturities greater than one year, and a portion of other deposits that are expected to stay on deposit during a stressed event. The effect of the ratio also constrains a financial institution's ability to issue a significant amount of debt outside the 30-day review period in the LCR. Implementation has been delayed until 2018 because of the significant amount of rulemaking yet to be done and because of concerns expressed by various national regulators and institutions that the ratio may not appropriately capture jurisdictional nuances that may affect national banking systems differently."
Finally, the Wells publication adds in "The Inside Track," "The Fed's commitment to the zero interest rate policy seems even stronger as discussions about a second phase of quantitative easing have picked up. There continues to be a disconnect between the issuers' desire to fund longer and market participants' need for shorter-term investments -- an issue that we do not think will be resolved easily. Although we've seen some securities issued that bridge that gap, demand continues to outstrip supply, and we believe that over the longer term, the yield curve will steepen further. With much rule-writing to be done in the coming months, and a somewhat unsettled credit environment, there is still a fair amount of uncertainty in the money markets. In light of all of this, we think it is wise to continue to focus our investment strategy on that stable NAV and a high degree of portfolio liquidity."
